South China Morning Post
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A view of a smokestack of the Wujing Coal-Electricity Power Station in Shanghai on September 28. Beijing is seeking to alleviate its energy crunch by ramping up domestic coal production and stepping up imports. Photo: AFP
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley

Despite soaring energy prices, China shouldn’t tighten monetary policy

  • Central banks in emerging markets may feel obliged to react to rising energy prices, even though tighter monetary policy won’t necessarily be effective against them
  • As the People’s Bank of China is no doubt aware, higher interest rates might leave both consumers and companies even more financially vulnerable
Neal Kimberley
Neal Kimberley
Why you can trust SCMP
Central banks in emerging market economies face a quandary. Soaring food and energy prices may prompt some to accelerate interest rate rises in an attempt to address these inflationary impulses. These price pressures will also have an impact on the Chinese economy but the People’s Bank of China should stick to its current course of steady to easier monetary policy.
China’s economy is in transition. Beijing is pushing on with efforts to reduce leverage in the real estate sector. It is pursuing a goal of common prosperity which, by seeking to address income disparities, should also support China’s drive towards a dual circulation economy where domestic demand and export-led growth become more evenly balanced.

Navigating such a complex transition will require supportive monetary policy conditions but the PBOC will also have to consider the monetary policy implications of ripple effects arising from a world economy rebounding from the Covid-19 pandemic.

That rebound has fuelled a resurgence in worldwide demand for energy and yet, in recent years, new investment in fossil fuel extraction has been trimmed in line with international efforts to combat climate change. Investment has instead flowed into clean renewable energy projects but the reality is that, for now at least, renewables cannot yet fully replace traditional energy sources.
The result is that there is currently a mismatch between global energy demand and supply that has resulted in dramatic spikes in fuel prices which will, in all likelihood, only feed through into already-elevated food prices and higher levels of general inflation.
The United Nations’ Food and Agriculture Organisation said on October 7 that world food commodity prices rose in September. Indeed the FAO Food Price Index averaged 130 points last month, up 32.8 per cent from September 2020 and close to the level of 131.9 seen in 2011, a year when elevated food prices played no small part in triggering social unrest in a series of events that came to be known as the Arab spring.
In contrast, possibly to Beijing’s relief, food prices in China fell year on year in both July and August.

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Power crisis in China leaves highway in the dark

Power crisis in China leaves highway in the dark

In reality, tighter monetary policy won’t necessarily bear down on supply-side-related rises in energy and food prices, but central banks in many emerging markets may feel obliged to react.

While their developed market counterparts might choose to “look through” more volatile, “noncore” prices for food and energy when calibrating policy, emerging economy central banks might feel greater pressure to act to bolster public confidence, given that populations with lower per capita disposable incomes will always be more directly affected by material food and energy price rises.

From iPhones to milk, China’s energy crisis ripples across global economy

In China’s case, energy shortfalls have already translated into power cuts and electricity rationing across many provinces but Beijing is seeking to alleviate the energy crunch by ramping up domestic coal production and stepping up imports from countries such as Colombia, Kazakhstan, Mozambique, Myanmar and South Africa, although the flow of Australian thermal coal into China remains adversely affected by the poor state of Beijing-Canberra relations.

In addition, the China Banking and Insurance Regulatory Commission last week told lenders to support qualified mines and power plants so as to facilitate a rise in thermal coal and electricity output.

It might not be a very green approach to countering China’s energy crunch but Beijing has to deal with immediate problems and pay up as needed, before returning to its plan for a carbon-neutral future.

Nevertheless, unless equilibrium in energy prices is restored, either through a marked increase in supply or through demand destruction, elevated energy prices may be here to stay for a while, leaving consumers with less money to spend on other goods, which in turn accentuates the problems of manufacturers whose own fuel bills have also risen.

In such circumstances, as the PBOC will no doubt be aware, not only is tighter local monetary policy ineffective against global energy price rises, higher interest rates may also exacerbate an already difficult situation by increasing personal and corporate debt service costs, leaving both consumers and companies even more financially vulnerable.

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Unlike many other central banks, the PBOC took a more nuanced approach to the pandemic, providing targeted monetary policy support but not slashing interest rates or resorting to massive programmes of quantitative easing.

In the post-pandemic environment, while soaring energy prices that are driving inflation higher may prompt some central banks to tighten monetary policy, policymakers in China should not be tempted down this path.

China’s economy will be better served by the PBOC sticking with its current monetary policy.

Neal Kimberley is a commentator on macroeconomics and financial markets

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